Special Reports

Safety Net

The safety net is intended to reduce systemic risk by protecting financial institutions and their creditors from failure. However, federal guarantees can encourage imprudent risk taking, which may reduce economic welfare. The Richmond Fed periodically estimates the size of the safety net—most recently in February 2013 using data as of Dec. 31, 2011.

Economists at the Richmond Fed first estimated the size of the safety net as it stood at the end of 1999. John Walter and John Weinberg put a dollar figure on private liabilities that might be distorted by safety net protections in terms of amount issued or price paid. Basing their estimate on past government actions, they found that approximately 45 percent of all financial firm liabilities were protected.

Ten years later, Nadezhda Malysheva and John Walter, of the Richmond Fed, re-estimated the size of the safety net. They based their updated calculations on the government’s response to the financial crisis (e.g., assistance to specific firms, such as Bear Stearns and AIG, as well as broad programs, such as the Fed’s Term Auction Facility, its Primary Dealer Credit Facility, and the government’s $700 billion Troubled Asset Relief Program). They found that the safety net had expanded to include as much as 59 percent of all financial firm liabilities.

Most recently, Richmond Fed researchers (Liz Marshall, Sabrina Pellerin, and John Walter) estimated that the safety net included as much as 61 percent of all financial firm liabilities at the end of 2011.* This was roughly the same as in 2009 despite the fact that Dodd-Frank produced far-reaching changes in the financial sector. The researchers followed reasoning similar to that used in previous estimates.

Future Plans

Richmond Fed economists plan to continue to provide new estimates in response to legislative and regulatory actions or policymaker comments that could change public perceptions of the size of the safety net.

*Liz Marshall, Sabrina Pellerin, and John Walter wish to express their greatest appreciation to Joshua Arnold, Kristin Barnes, Belinda Coles, Tim Pudner, and Deanna Struk for their advice and many hours invested gathering and analyzing data.